Fair Value on Vix Options

Discussion in 'Options' started by drenaud, May 5, 2010.

  1. drenaud


    Is buying and selling Vix options pure speculation?

    Are there any tools that would help determine some sort of 'fair value.'

    Thanks in advance,

  2. dmo


  3. There is a relationship between a VIX options position and the var-futures. Unfortunately, the var-futures trade by appointment. The VIX combos (synthetic futures) trade within pennies of the actual futures.
  4. drenaud


    Could you explain what is a synthetic future? (combos)


  5. drenaud



    Great video. I am still trying to figure out if there are models out there that will calculate a 'fair' price for a particular vix option given the users assumptions about the future.

    If you were buying or selling an option on an equity or futures you could input your view of future vol, interest rates etc and come up with a 'fair price.'

    If the market prices was significantly different you may chose to buy or sell to take advantage of the pricing differences.

    Even if a model doesn't always represent reality it seems like it is a good starting point.

  6. dmo


    If we're talking about, say, gold futures and options on futures - buy a gold call and sell a gold put of the same strike and you are long the synthetic futures contract. Sell a call and buy a put of the same strike and you are short the synthetic futures.
  7. dmo


    Well, you know what the model's assumptions are. So if you can point to one or more of those assumptions and have a firm conviction they're wrong, then you've decided that the option is either overvalued or undervalued. Once you've decided that, you have a pretty good clue what to do next.

    If implied volatility of an option today is 40% and you think that soon it will be 60%, then you've decided that in your opinion the option is underpriced. Or you may be of the opinion that a fundamental assumption on which the model is based is just plain wrong.

    A good example is Warren Buffett's sale of billions of dollars worth of puts on the stock market. He looked at a long-term chart of the stock market - which shows a definite steady uptrend over time - and decided the pricing model's assumption of random-walk pricing of the stock market and a lognormal probability distribution are baloney. Based on that, he decided he could sell puts at way over what he considered fair value.